Not long ago, the typical investor had little exposure to, or awareness of, alternative investments. The term itself was vague and the corresponding investments felt reserved for large institutions and the ultra-wealthy. That has changed. The largest alternative asset managers now advertise during the evening news, sign endorsement deals with professional athletes and command steady attention in the financial press, where topics like private credit have received frequent top billing.
At Johnson Financial Group, none of this is new to us. We have encouraged thoughtful inclusion of alternative strategies for many years, which means we are well practiced at answering the question clients most often ask: Why should I invest in alternatives in the first place?
The honest answer starts not with the investments themselves, but with you.
It Begins with Your Goals
Your personal goals evolve over a lifetime. Starting a family, buying a home, building a business, planning for retirement, leaving a legacy. The goals change, but what a portfolio needs to deliver does not. Throughout life, a well-built portfolio is asked to do three timeless things: Grow your wealth, generate income and diversify your risk.
We recommend alternatives for one fundamental reason. We believe they improve the probability that you reach your financial destination. How any single investment contributes to that cause is an important question, but a secondary one. Above all, we believe your odds of success improve when you expand the set of opportunities your money can access beyond traditional stocks and bonds.
Why the Traditional Playbook Needs Reinforcements
In recent decades, a mix of public stocks, bonds and cash was enough to do all three jobs: Grow your wealth, generate income and diversify your risk. Today, that traditional portfolio faces real headwinds worth understanding:
- Shrinking public markets: A growing number of established companies choose to remain privately owned. Roughly 86% of U.S. companies with more than $100 million in revenue are privately held, meaning a significant majority of large businesses are simply unavailable to investors who invest strictly in public markets.
- Public market concentration: A small number of very large companies have driven a disproportionate share of stock market gains in recent years, leaving traditional portfolios more deeply exposed to the fortunes of a handful of names than many investors realize.
- Elevated stock/bond correlation: The classic role of high-quality bonds has been to cushion a portfolio when stocks fall. But that shock absorbing quality has been challenged in recent years. After decades of moving in opposite directions, stocks and bonds have increasingly moved together. When your two main investment allocations rise and fall in tandem, the natural diversification and protection a portfolio is designed to provide is eroded.
None of this means the traditional portfolio is broken. It means it benefits from reinforcements, namely additional sources of return and risk that do not all depend on the same things.
So, What are Alternatives?
Put simply, alternative investments are assets that fall outside traditional stocks and bonds, and they generally fall into two categories:
- Private asset classes: Owning or lending to companies and assets that are not traded on public exchanges. The most common names include private equity, private credit, real estate and infrastructure.
- Flexible strategies: Approaches that use stocks and bonds in novel way, employing expanded tools such as hedging, or the ability to profit from both rising and falling markets, to produce a different kind of return.
The common thread is that their results are typically less dependent on the day-to-day sentiment of public markets. That independence is precisely what makes them valuable in a portfolio.
The Three Jobs Alternatives Can Do
Different alternatives are suited to different roles, but most serve one or more of these purposes:
- Growth: Some strategies offer attractive long-term return potential, generated either through the specialized expertise of a skilled manager, or simply by investing in quality businesses which choose to remain private. Private companies can also focus on long term value creation without the quarterly pressure public companies face.
- Income: Certain alternatives, such as private credit and real estate, can generate higher income than traditional fixed income, often with features that adjust alongside inflation to help preserve your purchasing power. As traditional banks have pulled back from lending, private lenders have stepped in to fill the gap, a sector that has grown into a market of more than $1.6 trillion.
- Diversification: Because their returns are driven by different forces, many alternatives behave differently from public markets. Adding them can reduce the overall ups and downs of a portfolio and improve return for the level of risk taken.
How We Approach Alternatives at JFG
Simply investing in alternatives is not the point. Disciplined and intentional investment is. Importantly, we do not try to invest in every category of alternatives. We are selective. Multiple teams across our firm follow a structured process to decide which asset classes deserve a place in client portfolios, evaluating forward-looking market expectations and constructing diversified allocations.
When we identify a strategy worth pursuing, we put it through rigorous due diligence, analyzing the manager's track record, risk practices and structure, and we partner with respected specialists to deepen our review. We also weigh how best to deliver each opportunity, balancing access, liquidity and return potential for the right type of investor.
An Honest Word on the Trade-offs
Alternatives are important tools to consider, but they are not free of friction, and we believe in being candid about it. Compared with traditional investments, alternatives often require longer investment horizons and may offer less liquidity, with lock-up periods and less frequent opportunities to redeem. They tend to carry higher fees, including management and performance fees, which reduce returns. And they can involve more complex tax and reporting, such as K-1 forms.
For these reasons, alternatives are not right for everyone or for every dollar. Their suitability always depends on your individual goals, your tolerance for risk and your time horizon, which is exactly the conversation we are here to have with you.
The Bottom Line
We invest in alternatives because we believe they expand the ways of achieving your goals. They can add growth where public markets fall short, income where traditional bonds struggle and diversification where stocks and bonds increasingly move together. Used thoughtfully and selectively, the only way we use them, they help build portfolios designed to weather a wider range of conditions and carry you toward the future you are working toward.
As always, your advisor is the best place to start a conversation about whether alternatives belong in your plan.
